Be Your Own Boss (BYOB) Part 2

Be Your Own Boss (BYOB). That acronym used to have a different meaning for most folks, but here it means taking your future into your own hands. 

The Franchise Process – The franchising process is a complex process with well identified steps that a prospective franchisee must follow. Contrary to one previous comment, a franchisee is very much in charge of his company’s performance and responsible for making decisions as well as determining his own destiny. The franchise company (franchisor) provides support and restrictions intended to protect the quality of the brand; a concept important to all franchisees. The most important step in the franchise process is a detailed review of the federally mandated Franchise Disclosure Document (FDD). The following is an everyday language explanation of the FDD developed to inform my clients.

Franchise Disclosure Document - The purpose of the Franchise Disclosure Document (FDD) is to provide prospective franchisees with information on the franchisor, the franchise system, and the agreements they will need to sign so that they can make an informed decision. In addition to the disclosure portion of the document, the FDD includes copies of the franchise agreement and other agreements the franchisee will be required to sign, together with the franchisor's financial statements.

What appears in the FDD? In a nutshell, it includes information on the franchisor, the company's key staff, management's experience in franchise management, the franchisor's bankruptcy and litigation history, and the initial and ongoing fees involved in opening and running a franchise.

Also included is information on the required investment, purchases you will be required to make from the franchisor or from approved suppliers, and territory rights you will be granted. You also find information about your legal responsibilities as a franchisee and the responsibility of the franchisor to you.

In addition, the FDD presents information about the company-owned locations and on the franchisees in the system, including the number of franchises opened, the number closed and transferred and, most importantly, a list of existing and former franchisees with their contact information.

The cover pages contain interesting information that every prospective franchisee should read and understand. It states that the Federal Trade Commission hasn't checked the document and doesn't know whether it's correct. It reminds them to read the entire document. It encourages them to take their time in making their franchise decision. It suggests that the FDD and the franchise agreement be reviewed by an advisor, such as a lawyer or accountant. It asks that the FTC be notified if anything seems wrong with the document, and finally it recommends that you review the franchising laws in the particular state.

The second page of the FDD contains a summary of the franchise offering as well as a summary of the investment that the franchisee is required to make. It also contains information on some of the risk factors that a franchisee should know about before signing a franchise agreement.

Item 1: The Franchisor, Its Predecessors, and Affiliates - In this section, the franchisor provides a description of the company and the franchise being offered. In Item 1, the franchisor is required to disclose the following information:

1.   The name of the franchisor, its predecessors, and its affiliates.

2.   The name under which the franchisor does business.

3.   The franchisor's address

4.   The state of incorporation of the franchisor or the type of business organization of the franchisor.

5.   The franchisor's business and the type of franchise to be offered

6.   The prior business experience of the franchisor, its predecessor, and its affiliates.

Item 2: Business Experience - Here, the prospective franchisee gets biographical and professional information about the franchisor and its officers, directors, and executives. This section tells them who they will be going into business with.

Item 3: Litigation - In the UFOOC, you won't find information about all the litigation that the franchisor or the franchisor's management has been involved in. The rules require that only relevant current and past criminal and civil litigation for the franchisor and its management be disclosed.

Item 4: Bankruptcy - Sometimes franchisors or members of their management have gone through a bankruptcy. It's important information that every franchisee needs to know because it can tell you whether there is a pattern of bankruptcy by the people and company you will be entering into a relationship with.

Item 5: Initial Franchise Fee - Item 5 provides information about the initial fees you will pay to the franchisor. It tells what payments the franchisee makes to the franchisor prior to opening the business. It also tells you whether the fees are not uniform to all the franchisees and discloses the range and factors that determine the amount of the fee.

Item 6: Other Fees - This item provides a description of all other recurring fees or payment that the franchisee must make to the franchisor, including: royalties, advertising, training fees, transfer fees, audit costs, renewal fees, and any other miscellaneous fees for service that the franchisor provides.

Item 7: Initial Investment - Item 7 is in a table format. The table includes all the expenditures a franchisee is required to make to establish the franchise. In addition to a range of amount the franchisee must invest for each start-up expenditure, the franchisor discloses the method of payment, when it is due, who the payment will be made to, whether they payment is refundable, and whether it is financed.

Item 8: Restriction on Sources of Products and Services - The franchisor may have restrictions on what the franchisee can buy for the business and where the franchisee can purchase those items. There are many reasons that a franchisor restricts sources, including a desire to ensure consistency and quality. The franchisee may be obligated to purchase or lease products and services from the franchisor or from suppliers approved by the franchisor. The franchisor may also provide the franchisee with specifications for any of the goods, services, supplies, fixtures, equipment, inventory, computer hardware or software, or other items the franchisee uses in the business. The franchisor usually has the right to approve or revoke approval of a supplier, or to make changes to its specifications for products and services the franchisee uses.

Item 9: Franchisee's Obligations - Item 9 provides a reference table that indicates where in the franchise agreement franchisees can find certain obligations they agree to. The list informs the franchisee of the obligation, where it can be found elsewhere in the FDD, and where it can be found in the franchise agreement. The details of the obligations are not discussed in Item 9. Not all franchisees in every system have the same obligations.

Item 10: Financing Available - Some franchise systems provide financing assistance to their franchisees. Item 10 describes the terms and conditions of any financing arrangements offered directly or indirectly by the franchisor.

Item 11: Franchisor's Obligations - When you invest in a franchise, you expect the franchisor to provide you with certain services. Every franchise system provides different types and levels of service to its franchisees. It's important that you clearly understand what you will get.

Item 12: Territory - Not every franchisor provides its franchisees with an exclusive territory. When franchisors do make that provision, the exclusive territory will vary for each franchise system and may vary depending on the circumstances within a system.

Item 13: Trademarks - This section provides the franchisor with information about the franchisor's trademarks, service marks, and trade names that will be used.

Item 14: Patents, Copyrights, and Proprietary Information - This section provides franchisees with information concerning any patents or copyrights the franchisor may have and how they may be used by the franchisee.

Item 15: Obligation to Participate in the Operation of the Franchise Business - Some franchise systems require franchisees to devote their full time to the operation of the business. Others may allow for absentee ownership, or management by a manager trained by the franchisor. Different franchisors have different requirements concerning the obligations of the franchisee to participate in the actual operation of the business.

Item 16: Restrictions on What the Franchisee May Sell - Item 8 discussed any restrictions by franchisors on the suppliers and specification of the products used by the franchisee. This section deals with any restrictions on the goods and services that the franchisee may offer to its customers.

Item 17: Renewal, Termination, Transfers & Dispute Resolution - This section provides the franchisee with information, in a table format, concerning the terms of the agreement. Included in this section is information on: length of the initial term of the agreement; the number and duration of the renewal periods; reasons that the franchisor or franchisee may terminate the agreement, causes, and any cure period; the obligations of the parties after the termination of the agreement; the rights of the franchisor or the franchisee to transfer or assign the agreement to another person or company; the rights of the franchisor to purchase the franchisee's business; the in-term and post-term restrictions on competition with the franchise system; how the franchise agreement can be modified; what methods are provided for resolving disputes between the franchisor - litigation, arbitration, and mediation; and what states or country's law govern the contract.

Item 18: Public Figures - If the franchisor uses any public figure (celebrity or other public person) in the franchise system's name or symbol, the franchisor needs to disclose the amount the person is paid, the extent the public figure is involved in the actual management of the franchise system, and the public figure's total investment in the franchisor.

Item 19: Earnings Claim - This is one of the most important sections to franchisees. If the franchisor provides any information that a franchisee can use to estimate what she or he can earn from the business, it needs to be disclosed in Item 19. This may include specific levels or a range of actual or potential sales, costs, income, or profit for a franchise or non-franchised location. Earnings claims are a particularly sensitive area in franchising.

Item 20: List of Franchise Outlets - This section provides information regarding the locations operated in the system. It includes: the number of franchises and company-owned locations by state; the names, addresses, and telephone numbers of franchisees; the estimated number of franchises to be sold in the next year; the number of franchises transferred, canceled, or terminated; the number of franchises that have not been renewed by the franchisor or have been reacquired by the franchisor. The franchisor is required to provide you with the names and last known addresses and telephone numbers of every franchisee who has had an outlet terminated, canceled, or not renewed, or who otherwise ceased doing business under the franchise agreement during the past year.

Item 21: Financial Statements - Franchisors are required to include their audited financial statements for the past three years or for a shorter period if the franchisor has not been in business for three years.

Item 22: Contracts - Item 22 provides you with a list of the franchise agreement or license agreement and all other related agreements that the franchisee will be required to sign. These agreements must be attached as exhibits to the FDD.

Item 23: Receipt - The franchisee will be required to sign a receipt that he received the FDD. Two copies of the receipt form are provided in Item 23. The franchisee must wait two weeks after signing the receipt before initiating the franchise agreement.

Typical Attachments:

1.   Franchise Agreement

2.   Franchisor Financial Statement

3.   Other Pertinent Documents

I hope you enjoyed this article. More on BYOB next week - jim@jimdavisassociates.com